Summary

Results in Brief

State law requires that every person licensed to practice law in California belong to the State Bar of California (State Bar), a public corporation within the State’s judicial branch. Supported primarily by member fees, the State Bar’s duties include regulating the conduct of attorneys through its attorney discipline system as well as administering the California Bar exam. State law requires the State Bar to provide its stakeholders with various reports detailing its financial situation. However, in recent years, the State Bar’s financial reports have contained errors and lacked transparency, and these weaknesses have limited stakeholders’ ability to understand the State Bar’s operations and the Legislature’s ability to ensure the appropriateness of the State Bar’s fees.

For example, the State Bar has not taken critical steps to ensure that it has the funds necessary to reimburse members of the public who suffer financial losses because of dishonest attorneys, nor has the State Bar clearly informed stakeholders of the amounts related to such claims that it estimates it will pay. Specifically, the primary purpose of the State Bar’s Client Security Fund is to compensate victims of dishonest attorneys through a claims process. However, the number of claim applications to the Client Security Fund program soared beginning around 2009, in large part because many Californians had become victims of loan modification schemes. By the end of 2015, the State Bar indicated it had about 5,500 applications either in process or awaiting payment, and it estimated that it would pay a total of about $18.9 million related to those claims. Unfortunately, the available balance in the Client Security Fund had dropped to approximately $2.2 million by that time; this lowered balance thus severely reduced the State Bar’s ability to pay these claims.

Although the State Bar recognized the impending shortfall in its Client Security Fund at least as early as 2011, not only did it fail to take steps to address the problem or to communicate the fund’s true financial situation, it did the opposite: In 2012 the State Bar eliminated from its financial statements any disclosure of future amounts it expected to pay related to the Client Security Fund, reporting instead that the fund’s balance had improved. Further, because the State Bar lacked the funds necessary to pay claims, it slowed its claims processing from about 18 months to about 36 months, potentially harming victims who needed these resources. It has recently taken some steps toward a solution, such as transferring $2 million from other funds to the Client Security Fund. However, unless the State Bar takes additional significant actions, victims of dishonest attorneys will continue to have to wait years for their claims to be paid.

We identified a number of other instances in which the State Bar’s reports lacked transparency or contained errors, and these problems undercut the reports’ usefulness for the decision makers and stakeholders who rely on them. For example, because the State Bar failed to establish a reasonable process for allocating the costs of information technology projects, it identified the balance in its Technology Improvement Fund as unrestricted—or available for general use—when, in fact, that money could only be used for specific purposes. Similarly, the State Bar inaccurately identified its Legal Services Trust Fund balance as unrestricted, even though state law restricts the fund to awarding grants to entities that provide free legal services to low‑income Californians. In addition, over the past five years, the State Bar has repeatedly changed the way it presents indirect costs in its financial statements, creating apparent fluctuations in its funds’ year‑to‑year spending and reducing a stakeholder’s ability to compare one year to another.

In February 2016, the State Bar established a new reserve policy for its funds, and our review found that its most significant funds now comply with that policy. However, we have a number of concerns about the State Bar’s budgeting process. Specifically, the State Bar lacks a clear, documented methodology for establishing its budget forecasts. In fact, it was unable to provide us with documentation of either its budget assumptions or its methodology. Further, the State Bar has not reported its budget assumptions and methodology to the Legislature, despite the fact that the Legislature relies on that budget to ensure the reasonableness of the State Bar’s fees. Finally, after we raised concerns about one of the provisions in its building loans, the State Bar modified the provision which might have otherwise restricted the Legislature’s ability to lower the State Bar’s fees.

Our audit further found that in the absence of oversight, the State Bar has made some questionable or inappropriate financial decisions. For example, in 2013 the State Bar created a nonprofit foundation to purportedly collect money from donors and to administer activities benefiting two of its programs. Although state law allows the State Bar to create nonprofit organizations for the purpose of generating revenue for its operations, about $22,000 of the $33,000 in expenses the State Bar recorded in the foundation’s fund from 2013 through 2015 were for purposes unrelated to the two programs the foundation was established to support. In fact, the State Bar incurred nearly $4,800 of these expenses for a dinner and hotel stay it charged to the foundation that took place two months before the foundation was even created. Moreover, in December 2015, without the knowledge or approval of its board of trustees, the State Bar transferred from its general fund almost $14,800 to eliminate a deficit in the foundation’s fund. Lacking proper oversight, the State Bar could create a similar nonprofit in the future and use it for questionable purposes.

Finally, the State Bar has continued to provide its executives significantly more generous salaries and benefits than those received by other executives in comparable positions in state government. In fact, the salary ranges for the State Bar’s 13 top executives exceed the salary of the governor. If the State Bar capped all of its executive staff salaries below the position level of chief operations officer (operations officer) at the highest level allowed for similar state positions, it could save as much as $428,000 annually. Although the State Bar is conducting a comprehensive compensation and benefits study, it had not included in its evaluation the data for salaries or benefits of the state government’s executive branch. After we raised this issue, the State Bar added state executive branch salary and benefit comparisons to its compensation study covering staff involved in its disciplinary activities. According to the State Bar’s operations officer, the State Bar also plans to include comparisons to state executive branch salaries and benefits in its agency‑wide compensation study.

In the past year, the State Bar’s management team has undergone significant turnover. Given the magnitude of those changes, we are optimistic that the State Bar may improve the clarity of its financial communications and that its financial decisions may reflect better judgment. However, we also believe that increased oversight and improved financial processes could reduce the risk that the State Bar will face similar problems in the future.

Recommendations

To reduce the length of time that victims of dishonest lawyers must wait for reimbursement from the Client Security Fund, the State Bar should continue to explore fund transfers, member fee increases, and operating efficiencies that would increase resources available for payouts.

To reduce the risk of errors in its financial reporting, the State Bar should update its procedures to include detailed steps that staff should take to prepare financial statements and to ensure that the statements are accurate and complete.
To increase the transparency and comparability of its financial information, the State Bar should do the following:

Limit significant changes in its indirect cost reporting.

Clearly disclose any changes in its accounting practices.

Disclose the reasons for any significant changes to program costs.

To ensure that it accounts appropriately for information technology project costs and their related funding sources, the State Bar should do the following:

Apply this new cost‑allocation method to the costs of its Technology Improvement Fund.

To make certain that it informs stakeholders of conditions that may affect its policy and programmatic decisions, the State Bar should document the assumptions and methodology underlying its budget estimates. It should present such assumptions and methodology concisely in the final budget document it provides to its board and the Legislature.
To make certain that the Legislature is not limited in its ability to set member fees, the Legislature should require the State Bar to notify or seek its approval when the State Bar plans to pledge its revenue for a period that exceeds 12 months or that overlaps fiscal years.
To ensure that it retains appropriate supervision and control over the State Bar’s financial affairs, the board should establish a policy that includes the following:
• A description of the parameters for the creation of nonprofit organizations that limits such organizations to the purposes consistent with the law and the State Bar’s mission.
• A description of the board’s oversight role in relation to the State Bar’s nonprofit organizations.
• Requirements that the State Bar develop policies and procedures to prevent the mingling of its funds and any nonprofit organization’s funds.
To improve its oversight of the State Bar’s financial affairs, the Legislature should require the State Bar to disclose the creation of and use of nonprofit organizations, including the nonprofits’ annual budgets and reports on their financial conditions explaining the sources and uses of the nonprofits’ funding.

To ensure that the compensation it provides its executives is reasonable, the State Bar should include in the comprehensive salary and benefits study it plans to complete by October 2016 the data for salaries and benefits for comparable positions in the state government’s executive branch.

Agency Comments

The State Bar of California generally agrees with the recommendations in our report, and indicated that it has already begun implementing some of them; however, it expressed concerns about certain report headings.